Big Investors Dodging Wall Street?
Investors responsible for more than $2 trillion recently gathered at a resort in the Canadian Rockies, far from the news media and, more important, far from Wall Street.Leo de Bever is a pioneer in the pension world and always thinking about a better future. Ever since he took over the helm at AIMCo, he`s been leading a crusade against fees, cutting the number of relationships with external managers and focusing on building internal capabilities.
Those in attendance, including leaders of Abu Dhabi’s sovereign wealth fund and France’s pension system, were there to consider ways to put their money to work together without paying fees to private equity firms and hedge funds. Over that weekend, three of the attendees completed the details of a $300 million investment in a clean-energy company.
The group holding the gathering, the Institutional Investors Roundtable, has kept a low public profile since it began in 2011, but it attracted 27 funds managing public money to its latest meeting and is spinning off concrete investments. The group is part of a much broader push by the world’s biggest pension and sovereign wealth funds to reduce their reliance on the Wall Street firms that used to manage almost all their money.
The efforts to change the way public money is managed are motivated, in no small part, by the big fees and lackluster performance that many hedge funds and private equity firms have delivered to their biggest clients in recent years. Investment managers like Leo de Bever, at the Canadian province of Alberta’s $70 billion fund, have found they can often manage their own money at a lower cost without losing out on returns.
“The big investors are saying, ‘Wait a minute, we don’t have to do this anymore,’ ” said Mr. de Bever, chief executive of the Alberta Investment Management Corporation, which hosted the April meeting in the Rockies.
The moves are not yet threatening to eat into the overall profits of the big hedge funds and private equity firms that cater to large international investors. Even the funds that are graduating to investing alone generally say they still use Wall Street firms for areas in which hiring an expert would be hard. But the moves point to a mistrust of Wall Street’s ability to deliver the kind of outsize returns it has long promised. This, in turn, is leading to a broader shift toward lower-cost methods of managing money.
For ordinary retirement savers, there has been a significant move away from expensive, actively managed mutual funds toward cheaper funds that passively track an index of stocks or bonds. Many sophisticated pension funds have been shifting to this sort of investing for years. Now, the big players are also searching for cheaper ways to put money into trickier investments like real estate and technology start-ups.
“Across the board, across every single asset class, we’ve seen movement toward saying, ‘We want more control over our assets,’ ” said Victoria Barbary, director of the Sovereign Wealth Center in London, which tracks the national funds that manage public money in places like Singapore and Norway. “It’s all a response to wanting more control and not wanting to pay fees.”
When Mr. de Bever took the helm of the Alberta fund, known as Aimco, in 2008, it had relationships with about 50 private equity firms. It has since cut that number to 12, and all new investments are being made by an internal team that Mr. de Bever hired in Edmonton.
Aimco has found that it generally has to pay private equity firms about 6 percent of any assets they manage each year. When the work is brought in house, the expenses drop to about 1 percent.
Mr. de Bever occasionally hears grumbling from the sophisticated New York firms who doubt his fund’s investing ability, he said. “They should leave it to the pros,” he has heard the firms say.
But a research paper written by two Harvard Business School professors, Josh Lerner and Victoria Ivashina, found that private equity-style investments made by seven large funds generally outperformed those that the funds made through private equity firms. The paper is being reviewed for publication.
Steve Judge, president of the Private Equity Growth Capital Council, said that “proven private equity firms deliver superior returns.”
“Those investing outside of traditional private equity partnerships will find it very challenging and expensive to recruit the talent and experience necessary to replicate those results,” Mr. Judge added.
Canadian funds like Aimco have led the shift toward direct investments, ever since the Ontario Teachers’ Pension Plan began building its own investing team in the 1990s. Public pension plans in the United States have been among the slowest to take up in-house investing largely because they can generally pay employees only public-sector salaries. That has limited their ability to hire people with investment experience.
In Wisconsin, though, the state’s $91 billion public pension fund, the nation’s ninth-largest, is looking for an employee to run a new program that will make private equity investments directly rather than through a fund. The fund has estimated it will save $19.3 million in fees over the next five years on the $500 million that will be put to work.
“The market giveth and the market taketh away, and there’s not much we can control out there — but fees are one area where we can,” said Michael Williamson, executive director of the State of Wisconsin Investment Board.
Over all, the Wisconsin fund is now managing 61 percent of its own money, up from 21 percent in 2007. Among the nation’s 200 largest pension funds, $932 billion was invested in-house last year, up from $787 billion in 2009, according to surveys by Pensions and Investments.
Wisconsin has been able to make changes because the Legislature voted to let the investment board pay higher salaries than other state agencies, including Wall Street-like bonuses. Oregon’s public pension fund has recently pushed for legislation that would allow it to do something similar, but that has faced opposition from public sector unions.
Recently, the most significant movement into in-house investing has come from the sovereign wealth funds that have been springing up in countries around the world. These funds are collectively estimated to hold about $4 trillion, and they often have fewer restrictions on how they invest than American pension funds.
Because there are so many new sovereign wealth funds, said Scott E. Kalb, former chief investment officer of the Korea Investment Corporation, they are more able to question the old ways of doing business with Wall Street.
‘They are trying to set the terms of how they want to invest,” said Mr. Kalb, who now runs the Sovereign Investor Institute. “And they’ve got the firepower to do it.”
Many of these funds are beginning by making what are known as co-investments, in which they put money into a company alongside a private equity company without paying any fees. But the Institutional Investors Roundtable is one of a number of efforts to allow sovereign wealth funds to make co-investments with one another, capitalizing on the wider array of geographical expertise.
The group is being run as a nonprofit and already has attracted two of the three largest sovereign wealth funds in the world: the China Investment Corporation and the Abu Dhabi Investment Authority. The group’s founder, the Canadian lawyer Christian Racicot, said the meetings were aimed at allowing funds with less experience to learn from those with more.
At one of the group’s early meetings, the China Investment Corporation and the Russian Direct Investment Fund discussed setting up what ended up being a $2 billion fund to make direct investments together.
The chief executive of the Russian fund, Kirill Dmitriev, said, “More and more there will be direct partnerships between different sovereign wealth funds.”
The $300 million investment that was recently completed was made by Alberta’s pension fund, a New Zealand sovereign wealth fund and a sovereign wealth fund from the Middle East that has not yet made its stake public.
Mr. de Bever, at the Alberta fund, said that because Wall Street firms had not been invited to the round table’s meetings, the events did not have the same fancy dinners and lush entertainment that were standard at conferences for funds like his. But he said that could be a good thing.
“The marketing and the wining and dining can get in the way of what needs to be done,” Mr. de Bever said. “This is about the people putting down their money, not the people who manage the money.”
AIMCo's recent deal with OMERS, acquiring Europe`s top movie theater chain, is an example of how Canadian funds are going direct, shunning private equity funds.
But reading the article above got me thinking of some conversations I had with other senior pension fund managers in Canada and the United States in regards to how effectively the large Canadian funds can compete with private equity giants.
I`ve covered this topic numerous times. In my last comment, Is the Canadian Model Full of Hot Air, I acknowledged the expertise of Canadian funds in direct investments but also expressed serious skepticism that they could compete with top private equity funds.
Jim Leech and Neil Petroff, the CEO and the CIO of the Ontario Teachers Pension Plan, told me they are competing with private equity funds and they have the advantage of having a much longer time horizon than PE funds which typically need to realize on investments in a span of six years. The longer time horizon allows pension funds to nurture a company back to health and not feel the pressure PE funds have to deal with.
Mark Wiseman, CEO of CPPIB, told me while they invest directly in infrastructure and real estate, when it comes to private equity, they invest and co-invest with top global funds. "If I can hire (TPG's) David Bonderman, I would, but I can't afford to pay his compensation."
All these leaders are smart as hell and there is truth in everything they say. There have been successful direct deals in private equity at OTPP, OMERS, AIMCo and other Canadian pension funds. But the bottom line is that when you need to allocate billions to private equity, you will be relying mostly on fund investments and co-investments. Period.
If I was sitting in Mark Wiseman's shoes, I'd be taking the exact same approach in private equity, selectively building up relationships with top PE funds and looking to co-invest with them on large transactions. Sure, there are costs to fund investments but that is the price you have to pay to gain access to top funds that have proven successful track records at delivering alpha in private equity. In order to do this successfully, you still need to hire experienced private equity professionals who know what they're doing when it comes direct, fund investments and co-investments.
Nonetheless, pension funds and sovereign wealth funds are right to bring assets internally and use their size and power to negotiate lower fees with external managers. I agree with Leo de Bever, you do not need relationships with 50 private equity funds or 100 hedge funds to add value. In fact, if that is your approach, then you're not fulfilling your fiduciary duties. All you're doing is contributing to Wall Street's feeding frenzy.
I have serious concerns about the approach many U.S. public pension funds take when it comes to investing and expressed them last week:
...had a discussion this morning with a senior U.S. pension fund manager who lamented about how the boards of U.S. public pension plans rely on their external consultants for investment decisions. "They do this for liability reasons," he explained.There are good pension consultants but there are many terrible ones too. Blindly shoving all of your pension clients in a few brand name funds will gain you board approval and access to capacity and follow-on funds but it's often a recipe for failure.
He told me that the consulting model is "all about volume," which is why the bulk of the money keeps going to the same brand name alternative investment managers. "The consultants are thinking of how many clients they can service using relationships with a handful of funds, not what is necessarily in the best interest of the pension plan. This means a lot of good managers with $300 million or less of assets under management are being overlooked."
There are many problems with the governance of U.S. public pension plans, compensation being one of the biggest hurdles. By contrast, Canada's top ten got the governance and compensation right. They're increasingly managing assets internally and co-investing with top external managers, lowering costs significantly and achieving better long-term results. This approach will help them navigate through this challenging investment landscape.
This senior U.S. pension fund manager also told me he thinks Bridgewater will suffer major redemptions this year as their performance is terrible. It seems like the world's biggest hedge fund is in deep trouble, struggling to cope with its explosive growth. We shall see if this is a transient problem but pension fund managers are taking notice.
Another senior U.S. pension fund manager told me he wasn't investing in a top private equity fund because he had "serious governance concerns." He basically thinks that power is too concentrated in the hands of the two senior partners and does not like their investment process. According to him, many of his peers are "not doing their homework" when it comes to looking at follow-on investments with top private equity funds.
The same issues are arising with hedge funds where the hype is finally being exposed. My discussions with Ron Mock, OTPP's next leader, taught me early on that even the best funds can experience serious setbacks, especially after assets explode up. In our last conversation, he told me that their "sweet spot" lies with hedge funds managing between $500M and $2B. "Those funds are generally performance hungry and they are not focusing on marketing like some of the larger funds which have become large asset gatherers."
At the end of the day, it's all about performance and alignment of interest. Large institutional investors are fed up with paying high fees and getting mediocre performance and many are openly questioning the approach they've taken in the past. Will Leo de Bever and a small group of large and powerful institutional investors change the future of how large funds are investing?
In many ways, Canada's top ten have already set a precedent but it's important to recognize that even among them, there are important differences in the approach they take. While they are increasingly bringing assets internally, some use external managers more aggressively and leverage significantly off these relationships. Others, like HOOPP, are leading the world and doing everything internally.
Finally, the World Pensions Council (WPC) is currently preparing for the upcoming ‘International Asset Owners Summit’ (IAO Forum) to be held in Asia Pacific in November 2013. Nicolas Firzli, the Director-General, told me over 100 Chairmen/CIOs from some of the world’s biggest pension funds and sovereign wealth funds will be in attendance. To get more information, contact him directly at admin@worldpensions.org.
Below, Singapore's GIC has reported a 20-year annualized real return of four per cent last year, compared to 3.9 per cent in the previous year. These are returns on the foreign reserves of the Singapore government. Investment analytics firm HedgeSpa estimates that the GIC policy portfolio returned 14 per cent in the fiscal year ended March 2013 -- that is on par with the 13.4 per cent return made by Norway's Government Pension Fund, the world's largest sovereign wealth fund.